Global bond yields are responding, without exception, to the spectre of higher and longer-lasting inflation. Inflation pressures remain broad based and have only been made worse from the impact of the Russian/Ukrainian war on commodity prices and supply chains.
Fortunately, consumer spending remains buoyant and supportive of further economic growth in 2022. A strong jobs market, pent-up demand and above average savings due to Covid are all helping – but for how long? Recent consumer sentiment surveys are not positive in this regard – most developed countries surveys point to consumer weakness ahead. How this develops will heavily depend on the actions of central banks in their efforts to get inflation back under control.
The chart below shows the Fed fund rate vs inflation since the late 1960’s. The experience has been that it is only possible to drive inflation sustainably lower by raising rates to above the level of inflation and keeping them there for an extended period. If the FOMC decides inflation will not moderate on its own, the first step would be to take the fed funds rate above the inflation rate. The core PCE inflation rate is ~5% y/y currently. That is a big step! The Fed is now likely in a “tighten until something breaks” mode. The key question remains: will it be inflation or economic growth that breaks first.
Source: Strategas Research Partners